SARB’s Kganyago injects some reality

South African Reserve Bank Governor Lesetja Kganyago has a message for the bond markets, economists, policymakers, the RET gang and the wider public. South Africa does not have ‘magical’ sources of money.

Reserve Bank Governor Lesetja Kganyago made his remarks on Thursday, 18 June in an online Zoom lecture to the Wits School of Governance. Kganyago is always a straight talker and, seated in his study which has served as his backdrop for the past three months, he came out swinging. The lecture was titled: “The South African Reserve Bank, the coronavirus shock, and ‘the age of magic money’.” 

“When the SARB began intervening in the South African government bond market, on 20 March, we had seen trading thin out, with even small transactions causing bond prices to move abruptly. By purchasing bonds in the secondary market, the SARB has helped restart price discovery and has encouraged the re-entry of private sector participants,” the governor noted. 

When liquidity is low, market volatility can be high, as a few orders can push prices significantly in either direction. Think of it this way: when flows are normal, a single trader has to compete with a lot of other traders. When no one else is in the market, you get to call the shots. Hence the SARB’s intervention in the markets as the big lockdown was bearing down on the economy. 

“Up to now, it appears our interventions have worked. Volatility has subsided and bond yields have largely normalised. While we are not targeting yields specifically, the fact that the benchmark 10-year yield is back to where it was in February suggests that stress in the system has eased,” the governor said. This is a crucial point. Amid the pandemic, South Africa lost its last investment-grade credit rating, and the economy is clearly cratering, which should drive yields — and government’s borrowing costs — higher. That yields are back to pre-pandemic levels is perhaps astonishing, but it is not magical.

It was at this point in the lecture that the governor began taking aim at some of the proposals to get the SARB to inject steroids into its bond-buying programme. 

“The proposals on the table for more bond buying are not modest. I have seen one call for a trillion-rand fiscal stimulus financed by the SARB, and another for SARB bond purchases of R10-20-billion per week to continue until ‘economic recovery is well underway’. These numbers imply that the SARB would be buying, more or less, all new debt for the foreseeable future. Such interventions would crowd pension funds and other institutional investors out of the bond market,” he said.

His point here was that other institutions that purchase assets with an eye to delivering a return to clients — which would include the pension funds of South Africans fortunate enough to not deposit their life savings in the likes of VBS Bank — would be pushed to the side.

That, Kganyago noted, would send a “dangerous signal.”

“In South Africa, the risk is that the domestic currency will no longer be issued by a credible, inflation-targeting central bank, but by one that is fully financing the public sector instead. Should we be going this way, some bondholders would probably be enthusiastic about a large bond purchase programme so they could dump their bonds on the SARB and minimise their losses. And why shouldn’t they be looking for a way out? Imagine the situation: we would be taking over public sector financing, with no clear plan for how to stop buying a potentially ever-larger issuance of bonds.”

In short, for some bondholders, it would indeed be a magical “Abracadabra” moment.

But the Constitution grounds the SARB in reality.

“The Constitution tells me the SARB must protect the value of the currency, and that we must have regular discussions with the Finance Minister. Nowhere does it say I can set conditions. As such, the SARB cannot take responsibility for solving a fiscal sustainability problem, nor can it jeopardise the value of the currency by agreeing to inflationary money printing,” the governor said. 

The governor also noted that well before the current pandemic, South Africa was getting poorer. He did not say so explicitly, but this is one of the many legacies of the ANC under Jacob Zuma.

Bottom line: if the government’s borrowing costs are rising, the SARB is not going to print money to fund it. Inflation is hardly a problem at the moment and the SARB — which has inflation targets — is not about to throw fuel on that fire. But it is going to put the concept of “magic money” on the stake.

In advanced economies, central banks with zero interest rates have an incentive to buy assets that might generate a return, even a small one. 

“This has been the exact situation of major advanced economies for much of the past decade, and it has given these central banks almost unlimited scope to buy assets. Given this extraordinary situation, one economist has described this as ‘the age of magic money’,” the governor said. 

“This is not, however, the situation in most emerging markets. For us, a persistent and unsterilised increase in bank reserves would create downward pressure on interest rates,” he said, which would trigger inflationary pressures in the economy, with no incentive for people to, for example, save.

The governor also noted that well before the current pandemic, South Africa was getting poorer. He did not say so explicitly, but this is one of the many legacies of the ANC under Jacob Zuma.

“We have just completed our worst growth decade on record – worse than the 1980s or the 1990s. On a per capita basis, South Africans have been getting poorer since 2013. In the world, we are slipping backwards. In 1960, South African incomes were around 26% of those in the US. They are now down to 13%. They were 128% of Brazil’s in 1960, a country to which we are often compared; they are now down to 65%. Rather, we risk following Argentina’s path, where ideological conflicts and unstable macroeconomic policies produced a steady economic decline.”

And then he added these kickers:

“In much of the period after 1994, we in South Africa surprised everyone by co-operating despite our differences and delivering robust and sustainable macroeconomic policies. But those accomplishments have faded. Instead, we now find ourselves sitting on the highest debt pile in our history, arguing about printing money and waving ideological banners at each other.”

“We have used up the legacy of low debt levels. Fortunately, we have achieved low inflation. We cannot squander that achievement on the quixotic belief that if we just engineer higher inflation, somehow growth will permanently rise. Our own experience shows that belief to be wrong, and we can set out now on a new path with low interest rates if we guard and value them. We have nearly all the ingredients needed to get permanently stronger economic growth, create jobs, and rid ourselves of poverty and inequality.”

On that note, he said: “Let’s open up for investment to increase our productivity.”

If there is a magic wand, many economists would say that is it. Abracadabra, folks.

 

Officially Published by Daily Maverick

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